January 1992
Vol 15 No 3
It’s the dawning of a new leap year. You’ll have one extra day at your disposal to use as you see fit. How you use it – and the other 365 days of 1992 – could ultimately determine the degree of success or failure that you achieve with the rest of your life!
That’s the way I like to approach each New Year. It’s too late to do anything about last year. But NEXT year I’ve got the opportunity to build on all the things I’ve learned in 1991 – and indeed, over all my life up until now – to make 1992 better. Just chanting motivational slogans won’t do the trick though. Maximizing each year takes work.
Before we can make 1992 better, we’ve got to find a way to measure our actual performance in 1991 to see whether we won or lost – and by how much. We’ve got to figure out what we did to create positive results and try to repeat those activities. We’ll try to eliminate the things that didn’t work for us. But the world is changing. So are the rules. We’ll have to skew our efforts to take advantage of those changes that will help us and to counter those that won’t. It looks as if our work is cut out for us. We’d better get started now.
YOU CAN’T SCORE A GOAL WITHOUT GOAL POSTS . . .
Back when I worked in Meteorology I learned that each time anything is measured, it must be compared to a standard of measurement. When we say a football field is 100 yards long, we compare it to the standard of length – the yard. When we say we are earning more, we compare our results to a standard of value – the dollar. In like fashion, before we can say that we’re successful, we’ll have to first establish our own personal standard against which our success will be measured. I know of no truly successful person who hasn’t done this.
Setting goals is hard. It requires that you understand yourself. When you have a conventional career, a lot of the goal setting is laid out for you on a path upward through the hierarchy. Entrepreneurs start at the top and the bottom at the same time. There’s no clear path. But there’s always a primary goal: SURVIVAL! That’s a good place to start. Rate of GROWTH and PROFITABILITY are naturals too. These can be objectively measured against balance sheets denominated in dollars, so tangible objectives can be established on a monthly basis. Then, progress can be measured on a goals scoreboard.
Look at any operating budget and you’ll see lots of goals. Each line item in a budget represents a defensive goal. By sticking to a financial diet, the operation can run lean and mean while it pursues bottom line income and asset-growth that goals management has set. This ‘business’ budget can be applied to ‘personal’ financial planning too. This is especially appropriate now, when there’s a real possibility that millions of people are going to see their credit cards cancelled in the next few months as the banking situation worsens. Now’s the time to start learning to live without personal credit. A 1992 goal?
On the side of offense, income goals need to be identified. Start with the needs of your business. How much is the minimum that it must gross each month in order to meet the budgeted expenses and still provide for growth and necessary profit margins? How much additional money must be taken out of the business to support the lifestyle goals you’ve set? At what point should you cut back expenditures and contribute personal funds back into the business? Possibly, the most important goal is to determine the point at which you’ve met your goals for the year and are able to reward yourself with that most precious of all commodities: TIME.
WE’VE GOT TO LEARN TO SEE AROUND CORNERS . . .
Every business plan is based on an economic premise and the real estate business is no exception. In 1992’s election year, politics are going to tilt our economic playing field more than ever. Bush is in trouble. He is getting the lowest approval ratings of his Presidency. Pat Buchanan and David Duke are attacking his right flank, threatening to draw off millions of votes. The Democrats and most of the State governments are nipping at his heels on the left. As the recession deepens, tax revenues are plummeting just when the costs of social spending are threatening to bankrupt the States. Beware!
We’ve seen how just the hint of government fiddling can cause the Dow Jones to drop 120 points in hours. The good news is that housing prices move too slowly and values are too varied in our disorderly market to ever be affected so precipitously. The bad news is that houses won’t begin to appreciate until market demand starts to drive the prices upward. Increasing household formation, employment, net after-tax purchasing power, and credit must be present for demand to rise. Government policy controls all these factors.
After tax income is affected by the rate of job growth and economic expansion; the degree to which earnings are siphoned off by taxes and regulatory requirements; the cost and the availability of business and personal credit. The numbers of households vary with population shifts, family formation, and divorce. High State taxes cause job-loss and migration of businesses and people to low taxed areas. We can see that in Nevada today.
Most people buy houses only after they’ve found employment, then worked and saved long enough to have accumulated a down payment. They’ve got to feel confident enough about future employment to make a commitment to buying a permanent home. Their job stability would be dependent upon their employer’s being able to sell goods and services so as to realize after tax profits. Suppose I were such an employee, look what I’d have to do:
In order to buy a house, I’d have to find a lender and qualify for a loan sufficient to pay for the house. The house price would reflect the costs of the land to the developer. In turn, these costs would include his taxes, impact fees, conformance to land-use and construction codes, employee taxes and benefits, materials and construction interest. His profit is only a small factor in the final price. Without all the government restrictions, the price might be cut by half with the same profit margins.
The lender is also hemmed in by regulations and the threat of the RTC witch hunt. He’ll require better credit records, job stability, more disposable income, a bigger down payment. All of these tightened criteria would limit my chances of buying the house I need. More importantly, they’d drive millions of buyers out of the market with the result that builders would have to sell at a loss, or go bankrupt, or default on construction loans. This would put more pressure on the lenders and the process would continue to get worse.
THERE ARE ONLY 450 BASIC POINTS BEFORE WE GET TO ZERO INTEREST . . .
Here’s where politics rears its ugly head. We’ve got the government cutting interest rates to about 4.5% or 450 basis points. In terms of inflation, that amounts to a negative REAL interest rate. If I can buy a house that appreciates at 5.0% and finance it with a loan at 4.5%, I can’t fail to make money sooner or later. So the costs of interest aren’t depressing the market. It’s the AVAILABILITY of loans.
Put yourself into the shoes of the lender. He’s beat and battered by costs of holding foreclosed properties, regulators, bank examiners, collapsing collateral values, defaults. All of a sudden Alan Greenspan at the FED lowers interest rates to him to 4.5%. Alan is hoping that the lender will then begin to expand credit and get the economy moving again, but our intrepid lender sees it a little differently. If he borrows at 4.5% from the FED and buys 7.5% government bonds, he gets a guaranteed 3% spread without any risk, administrative costs, and overhead expense. And he’ll be able to put the bonds into his reserve account and use it to expand his credit so he can do it all over again.
You really can’t blame the lenders for trying to make a profit. Wouldn’t we all do the same thing if we could? Government guaranteed wrap loans. But how does this help get the economy (and real estate) moving? It doesn’t! That’s why businesses can’t find loan money to expand. Why home seekers are priced out of the market by lack of credit. Why the recession is getting deeper. Why the tax base is collapsing around the ears of the bureaucrats who are seeing departmental budgets outrunning tax revenues. It’s a calamity.
EVERYBODY WANTS TO GO TO HEAVEN, BUT NOBODY WANTS TO DIE . . .
That’s one way of saying that voters seem to always elect politicians who will promise them more goodies and lower taxes at the same time. Then we’re all flabbergasted that George (Read My Lips) Bush has run up record deficits and allowed the economy to crater. Legislators are running like scared chickens, afraid to do anything lest they make things even worse. Where Carter inflated his way to wealth and Reagan borrowed his way out of trouble, Bush is apparently going to do nothing and see how that works out. All the while the economy continues to worsen. State governments are in even worse shape.
The latest victims don’t even realize that it’s happened to them yet. Retirees are about to start sharing the bath with the other misfortunates. As Corporate American goes deeper and deeper into debt with falling profit margins, businesses are beginning to discover the glories of Chapter 11 Bankruptcy. Under this code, they can renege on their union contracts, employees medical benefit plans, employee pension plans. While ERISA and IRS regulations penalize abandonment of pension plans, Bankruptcy statutes make it permissible. So millions of people who looked forward to a well-heeled comfortable retirement in the sunny climes are in for a rude shock once their corporate pension checks start bouncing. Before all you government retirees start feeling too smug, read on.
State governments have found a new cornucopia of funds to squander in the ‘public good’. (Read ‘pursuit of re-election’.) Pete Wilson lifted $1.3 Billion in California and Mario Cuomo’s taking aim on New York State’s public employees’ pension funds. By inflating estimates of future earnings, politicians then back down their calculators to find the ‘over funded’ present value. This is then siphoned off to meet current emergencies such as raising the pay of those who are still working. Retiree incomes are going to start to drop.
Let’s see. In setting a premise for the operating environment over the next year or so, we can see interest rates as pretty near the bottom. Normally, credit would continue to remain tight. Public expenditures would continue to slow down. Real estate construction and sales would remain slow in most areas. Non-government employment and wages would be drifting lower. Retail sales would be slowing after the holiday spurt. We’d be seeing increasing banking problems and rising foreclosures. Generally, those with discretionary funds would be remaining on the sidelines until a definite upward trend appeared. There’s a real possibility of a major stock market correction which could upset the apple cart. But, as the election comes closer, all bets are off if the polls continue to show Bush behind. Let’s talk inflation.
When nobody is willing to buy, people lower their prices to move the merchandise. If they’re homeowners, they just take their homes off the market and wait until demand strengthens. If they’re landlords, they can continue to collect rent and to generate income during their holding period. If they’re speculators who are paying high interest rates, they’ll hand the houses back to the lenders when they can, thereby spreading the distress to the next person in the food chain. All of this drives prices down. To get things moving again, buyers have to expect to make a profit when they eventually sell. They have to believe after tax sale proceeds and spendable profits are on the upswing.
The one thing that will put the most people to work in America is construction of housing. This takes low interest rates and available credit plus an optimistic public. Bush can do this by expanding the money supply and making it available as low cost credit. American doesn’t live in a vacuum. We have to compete in world markets for capital and trade. When we lower our interest rates, foreigners shift their investments to other countries where interest rates are higher. And they sell dollars they hold to buy other currencies. Thus, the dollar’s value plunges making American exports cheaper and foreign imports more expensive to Americans. This creates jobs in America at the expense of other countries in much the same way that cheaper Mexican labor attracts jobs away from America.
As American products begin to capture markets, employment, wages and salaries will pick up. So will our confidence. We’ll begin to start buying again. The first items we’ll buy will probably be automobiles. The next will be homes. And the cycle will start all over again with real estate becoming sought after first by USERS and shortly thereafter by developers, builders, investors, speculators. And as inflation rises, investors will leave the stock market and transfer their assets into real estate – just as they did during the Carter years – as a hedge against inflation.
I’LL GO OUT ON A LIMB. HERE’S MY FORECAST FOR NEXT YEAR
Congress went home for the year with a promise to revise taxes early in 1992. A real tax reduction will be viewed as inflationary by the world capital markets. Lower capital gains taxes will generate a lot of activity among investors – especially if it is limited to a single year. And political pressure on lenders could open credit flood gates. I think much of the above scenario will be played out commencing in the next 6 months so incumbents in Congress and the Administration can enter the election campaign as winners rather than as people who let Reagan’s perceived prosperity slip away. The negative effects of inflation on those with fixed incomes won’t appear until 1993. And many of the benefits of higher wages and spending power won’t be realized until later in the year, so this gives us an opportunity. Here’s what I’m going to do:
I’m going to remain alert to buying opportunities in the distress markets until things turn around. Many lenders are hanging on by their fingertips. They’ve got to get rid of defaulted loans and foreclosed properties. RTC is under pressure to unload. There will be lots of bargains this spring. Rents should remain strong. We’re going to test the market with small increases and I’m thinking about going with automatic 6 month increases pegged to hit in early August just before school starts if I see the FED printing money.
For those of you holding liquid funds, keep an eye on gold. The Benham Group 1 (800) 321-8321 offers a T-Bill Fund, a Gold Index Fund and an Adjustable Rate Government Securities Fund. These are all inflation hedged, and a proper balance between them will enable you to maintain a reasonable yield on liquid funds while hedging against spurting inflation that could catch you by surprise. In the meantime, use your fixed interest rate Notes to buy property with. They’ll be hurt by inflation. Ditto for bonds and stocks. If you’re selling and carrying back paper, index it to INCREASE in the consumer price index, or write one year adjustable Notes so you won’t be trapped by falling purchasing power of the payments you receive.
If you’re living on a fixed pension, you’ve got to start using inflation rather than becoming its victim. In today’s credit starved environment, you might start trying to negotiate a purchase Option on a house by supplementing the cash flow of the residents to help them make their payments. In a similar time period in the 1970s I was able to buy an Option simply by making the property tax payments each year for the owners. Options will protect you against inflation plus they’ll enable you to avoid management and maintenance problems, vacancy expenses and personal liability on loans. Options are the single most profitable form of high leverage with the lowest risk. Now’s the time to use them.
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